Silver's Vexing Slumber

Silver has had a rough year, slumping to major new secular lows. After sliding
on balance for years now, even the diehard silver bulls are losing faith in
their metal. But despite its vexing slumber, silver's price-appreciation potential
from today's levels remains enormous. Between radical underinvestment and very-high
speculator silver-futures shorting, silver is poised to see massive buying
as gold recovers.

Silver has proven very disappointing in 2015. Late last year, it was battered
down near $15.50 as gold plunged into the $1140s on extreme
futures shorting. That looked to be a decisive low, as silver spent the
next 8 months forming a strong technical base around $16. But unfortunately
in early July, silver fell to new lows near $15 as gold was crushed by an epic futures-shorting
attack. Silver was collateral damage.

Despite silver's unique and compelling investment merits, it has always been slaved
to gold. Investment demand on the margin is the dominant driver of silver's
price, despite only being around 1/5th of total global demand. The 4/7ths
of silver's demand from industrial fabrication, and 1/5th from jewelry, is
relatively stable year in and year out. The only demand category that
shifts dramatically comes from investors.

And their silver buying and selling is overwhelmingly driven by the fortunes
of gold. Capital floods into silver when gold is strong, catapulting
the white metal higher. And investors flee when gold is weak, pummeling silver
lower. Thanks to this ironclad sentiment link, silver is simply a leveraged
play on gold technically. The correlation between
silver prices and gold prices has proven incredibly high historically.

So with gold weak so far in 2015, silver had the deck stacked against it.
By late August when silver hit a major 6.0-year secular low just above $14,
it was down 9.9% year-to-date. Over that same span, gold had fallen 5.0%. That
2x ratio of silver's price movement relative to gold's is actually the dominant
rule of thumb historically. Silver tends to double the gains and losses
in gold, and gold hasn't fared well this year.

But interestingly, silver's vexing slumber is par for the course for this
volatile metal. Historically, silver's price action has been characterized
by long spans of sideways consolidations followed by explosive and massive
moves higher. Investors and speculators with the mental toughness to ride out
silver's long periods of inactivity are richly rewarded with huge wealth-multiplying
rallies. And the next one is overdue.

The last time silver was this down in the dumps and universally despised was
during 2008's epic stock panic, when silver was pummeled under $9. You couldn't
give silver away back then, just like today traders were totally convinced
silver was doomed to spiral lower indefinitely. Yet out of that very despair,
a monster bull was stealthily being born. Over the next 2.4 years, silver would
skyrocket 442.9% higher!

Over that span, the benchmark S&P 500 stock index merely gained 80.8%.
Silver was one of the best investments on the planet after the inexorable market
cycles finally turned favorable again. And since the financial markets are
forever cyclical, I strongly suspect silver is on the verge of another
one of its mighty uplegs. After plunging 70.8% in 4.3 years between April 2011
and August 2015, a trend change is coming.

It will be fueled by the overdue mean reversion higher in gold, which
is starting to recover from the most extreme speculator gold-futures-shorting
episode ever witnessed. Gold's coming upleg will get both investors and
speculators interested in silver again. And once they start buying back in,
they have a long ways to go to return to normal levels of capital deployed.
That's super-bullish for silver's outlook.

While much silver investment demand is small physical purchases, investors
and speculators each have one dominant venue for tracking their silver positions.
For investors it is BlackRock's iShares Silver Trust, which trades under the
symbol SLV. SLV acts as a conduit for the vast pools of stock-market capital
to flow into and out of physical silver bullion, and is the leading proxy of silver
investment demand.

This first chart looks at SLV's silver-bullion holdings held in trust for
its shareholders and the silver price over the past several years or so. Since
SLV is very transparent and publishes its silver holdings daily, it
offers an excellent window into investors' silver exposure. And it is super-low
now, which means there is much room for capital to return as silver inevitably
returns to favor again. Investors' buying potential is immense.

The biggest mistake traders are making on silver today is assuming these exceptionally-weak
conditions are normal and righteous. But nothing could be farther from the
truth! Back in early 2013, the US Fed spun up its third quantitative-easing
campaign to full steam. Unlike QE1 and QE2, QE3 was completely open-ended with
no predetermined size or end date. This Fed used this ambiguity to manipulate
traders' psychology.

Whenever the stock markets started to sell off, Fed officials were quick to
step up and declare that they could increase the size of QE3 if necessary.
So all dips were quickly bought, short circuiting normal market behavior.
This created
gross distortions in all kinds of markets, including stocks and the leading
alternative investment that moves contrary to them of gold. With stocks magically
levitating, gold was abandoned.

And naturally silver followed gold lower. Silver's average price in 2012 before
the Fed's manipulative QE3 debt-monetization campaign greatly skewed everything was
over $31! Given the extreme market conditions of the QE3 era, those pre-QE3
silver prices are much more representative of righteous fundamental silver-price
levels than today's. As QE3's vast distorting influence fades, silver will
return to normalcy.

One key driver of silver's powerful mean reversion higher will be the return
of stock investors to the white metal via SLV. In 2012 when silver averaged
near $31, SLV's holdings averaged 313.2m ounces. So that equates to stock-market
investors having an average daily silver exposure of $9.8b. While SLV silver
holdings have grown on balance since in these Fed-distorted years, capital
investment has still fallen.

With silver's bear market slashing its prevailing price levels, SLV's holdings
are worth a lot less in 2015 than they were in 2012. So far this year, SLV's
holdings have averaged 324.6m ounces or 3.6% over 2012's levels. But with an
average price just above $16, silver is 48.4% lower. That puts 2015's average
daily silver investment by American stock traders at $5.2b, just over half the
levels seen in 2012 before QE3.

So silver investment today is undeniably very low, which is not surprising
given silver's discouraging price action in recent years. That means there
is great potential for big investment buying as gold mean reverts higher and
silver follows over the coming years. While the value of SLV's holdings has
fallen with silver, they have actually enjoyed a strong uptrend in recent years
despite lower prevailing silver prices.

Several times in both 2013 and 2014, the heart of the extreme Fed-QE3 market
distortions, investors bought enough SLV shares to catapult its silver bullion
holdings way up to the overhead resistance line seen in this chart. And there's
no reason not to expect another surge back up to resistance, which is up near
351m ounces today. With SLV's holdings now near 322m, this would require another
29m ounces of buying.

And that's a lot of extra silver investment demand! According to the venerable
Silver Institute, global bar-and-coin demand ran 196m ounces in 2015. That
averages out to just over 16m per month. American stock investors have the
potential to essentially double that demand alone as they return to
SLV in the months ahead! It usually only takes a couple months for SLV's holdings
to surge from support to resistance.

Since SLV is a tracking ETF, differential buying and selling pressure on it
has to be directly shunted into underlying physical silver bullion. When stock
traders buy SLV shares faster than silver is being bought, this ETF's price
threatens to decouple to the upside and fail its tracking mission. Thus SLV's
custodians have to issue new ETF shares to meet and offset this excess demand,
and use the proceeds to buy silver.

So whenever SLV's bullion holdings are growing, it translates directly into
growth in global investment demand for silver. And naturally as silver's primary
driver, that really boosts its price. And provocatively even when SLV's holdings
revisit their 351m-ounce resistance, at 2015's average silver price just over
$16 its holdings would still only be worth $5.6b. That remains far below the
pre-QE3 average in 2012 of $9.8b.

In order to regain those kinds of SLV-investment levels at 351m ounces of
holdings, the silver price would have to surge an incredible 73% higher from
this year's average! That would take it back up to $28, which is certainly
not extreme in pre-QE3 terms. Back in April 2011 the last time silver was popular,
it skyrocketed above $48! This metal can really soar when investors and speculators
return in a major way.

While SLV is the dominant venue for tracking investment positions in
silver, American silver futures are the best place to track speculators' silver
bets. And just like SLV, they reveal lots of room for buying in the near future.
This is especially true on the short side. Speculators' silver-futures short
positions remain very high historically, and they are guaranteed near-future
buying as silver mean reverts higher.

The Fed's manipulative QE3 era greatly distorted speculators' silver-futures
positions too, particularly on the short side. Between 2009 to 2012, the last
normal years before QE3, speculators' downside bets on silver averaged 21.5k
contracts. Each contract controls 5000 ounces. Yet since QE3 started enticing
capital away from alternative investments, speculators' silver-futures shorting
has skyrocketed to record extremes.

The peaks in speculator shorting have grown since QE3's launch, most recently
hitting an astounding 81.6k contracts in early July! This was the highest level
seen since at least 1999, the extent of our silver-futures data, and almost
certainly ever. Speculators effectively borrowed all that silver that
they didn't own, and sold it. So they were legally and contractually obligated
to buy that silver back to repay their debts.

And indeed major short covering out of those recent extremes has already happened.
In the 8 weeks since early July's all-time record peak of speculator
silver-futures shorting, they have bought to cover 25.3k of these contracts.
So much short covering should have fueled a strong silver rally, but that didn't
happen in recent months. The reason is speculators' long positions paradoxically
mirrored their short ones.

Normally in futures markets, speculators' long and short positions move
in opposition. When they grow bullish as a herd, they both add longs
and reduce shorts to bet on further upside. When they become bearish, they
cull longs and grow shorts. So it is very odd to see speculators' longs and
shorts move in unison. Yet that's exactly what's happened in silver futures
for the better part of a year now, since last autumn.

At the same time American speculators bought to cover 25.3k short-side contracts
in recent months, they liquidated 17.1k long-side contracts. Thus over 2/3rds
of the upside silver-price influence by the short covering was completely
offset by long liquidations! This unnatural correlation will end as soon
as silver mounts a rally decisive enough to convince speculators that normalcy
is finally returning to this battered market.

But more exciting and bullish is the silver-futures short covering of recent
months remains far from running its course. During these Fed-QE3-stock-market-levitation
years starting in early 2013, the speculators' silver-futures short positions
have had support near 27k contracts. As this chart reveals, even within these
QE3-distorted years speculators' total shorts have already returned to this
level 5 separate times!

So there's little doubt that the next silver rally will drive speculators
to cover their shorts down to that 27k-contract support level again soon. And
that will require another 29.3k contracts of buying from the latest
levels, more than the 25.3k contracts already covered since that extreme record
peak. And that is a heck of a lot of silver buying, the equivalent of 146.5m
ounces over the couple months or so short covering takes!

Again global investment demand for silver averaged 16m ounces per month last
year. If the rest of the silver-futures short covering takes speculators two
months, we are looking at marginal new demand over 73m ounces per month! That
would more than quadruple normal silver investment demand while that
short covering is underway, catapulting silver prices higher and ending the
offsetting long liquidation.

Just as investors are radically underinvested in silver, speculators are still
radically short it today. Since 1999, speculators have only had higher silver-futures
short positions 3% of the time. So odds are they are going to have to
cover aggressively out of these extremes. Even a minor silver rally will spark
this self-feeding process, which is guaranteed by the extreme leverage
inherent in silver-futures trading.

Today futures speculators are required to have margin of just $6k for each
silver-futures contract that controls 5000 ounces of silver. Even at the dismal
$15 price levels today, that is worth $75k. So silver-futures speculators can
run leverage up to 12.5x on silver, dwarfing the decades-old legal limit in
the stock markets of 2x. At 12.5x, a mere 8% silver rally will totally wipe
out 100% of the capital risked shorting!

And once silver finally awakens from its long periods of consolidation slumber
and starts moving, it tends to rally fast. Speculators have to rush
to cover shorts or be annihilated, and the more buying they do the faster silver
rallies. This frantic speculator short covering usually provides the initial
spark that ignites new uplegs. Then as silver rallies, long-side speculators
and investors return to accelerate its gains.

These investors and speculators alike flock back to this metal with a vengeance
once gold paves the way, and odds are that day is rapidly nearing. There are
a variety of powerful factors that are aligning today to ignite a strong gold
upleg, this metal's long-overdue mean reversion higher out of recent years'
artificial price levels from Fed manipulation. Once that gets decisively underway,
silver will amplify its gains.

With the first Fed-rate-hike cycle in nearly a decade on the verge of launching,
these overvalued and overextended Fed-levitated
stock markets are due to roll over hard. That will really stoke demand for
prudent portfolio diversification through alternative investments led by gold,
which will lead to serious silver buying. And contrary to the popular myth
today, Fed-rate-hike cycles are not bearish for gold at all.

Last week I published an essay exploring a
comprehensive study I did on gold during all Fed-rate-hike cycles since
1971. In 6 of these 11 cycles, gold rallied dramatically by an average
of 61%! The bigger the rate-hike cycle, the better gold performed. And in
the other 5 where gold lost ground, the rate hikes always started when gold
was near a secular high. That certainly isn't the case today at these dismal
lows.

Fed-rate-hike cycles are bullish for gold and silver because they inflict
such great damage on stocks and bonds, leading investors to seek alternative
investments. Adding to the gold and silver bullishness, the precious metals
are both overdue for strong
seasonal rallies running into February on Asian demand. Not surprisingly
since the gold price drives silver, silver's
seasonals closely mirror gold's own seasonals.

Silver's coming dramatic mean reversion higher can be played in physical bars
and coins as well as the SLV silver ETF. But investors and speculators alike
can get far more bang for their buck in the battered stocks of silver miners.
Today these stocks are priced as if silver is going to grind lower forever,
ignoring the profitability of many silver miners even at today's low silver
prices. These stocks will skyrocket as silver recovers!

As hardcore contrarians at Zeal, we've long specialized in precious metals.
While this has been a tough sector thanks to the extreme Fed policies of recent
years, that is all due to reverse as the Fed starts the long
road to normalization. As the gross market distortions of QE3 and ZIRP
are gradually unwound, there is no doubt gold and silver will mean revert to
normal levels. The gains to be won in this sector are vast.

We've long published acclaimed weekly and monthly newsletters
for contrarian speculators and investors. They draw on our decades of experience,
knowledge, and wisdom to explain what's going on in the markets, why, and how
to trade them with specific stocks. Since 2001, all 700 stock trades recommended
in our newsletters have averaged annualized realized gains of +21.3%! We've
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The bottom line is silver looks poised to awaken from its vexing slumber.
The brutal bear market it has suffered due to the Fed's extreme market distortions
is ending as policy normalization begins. Silver is set up for lots of buying
as gold's recovery encourages traders to return. Not only are investors radically
underinvested today, but speculators remain heavily short which provides guaranteed
near-future buying.

Like all markets, silver is forever cyclical. It perpetually meanders from
in favor to out of favor and back again. And after falling on balance for years
as QE3 sucked capital and interest away from portfolio diversification with
alternative investments, silver is way overdue to reverse into its next major
bull. The brave contrarians willing to buy silver and its miners low before
this becomes widely apparent stand to earn fortunes.

If you have questions I would be more than happy to address
them through my private consulting business. Please visit www.zealllc.com/financial.htm for
more information.

Thoughts, comments, flames, letter-bombs? Fire away at zelotes@zealllc.com.
Due to my staggering and perpetually increasing e-mail load, I regret that
I am not able to respond to comments personally. I WILL read all messages though,
and really appreciate your feedback!

Mr. Hamilton, a private investor and contrarian analyst,
publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis
of markets, geopolitics, economics, finance, and investing delivered from an
explicitly pro-free market and laissez faire perspective. Please visit www.ZealLLC.com for
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